Decision Fatigue

As a business owner or incorporated professional (i.e. doctor, lawyer, etc.), you are faced with countless decisions on a day-to-day basis. One of the most complex decisions to make is how to allocate profits from your business or practice effectively. If you are facing this decision, congratulations because it likely means you have been successful at what you do. You may be familiar with reinvesting excess profits to rapidly grow, but eventually you may reach a point where you do not want to grow at the same pace anymore. Consider the following questions to help you decide what to do with surplus cash.

1. Is there a business need for the surplus cash?
2. Do you have an immediate personal need for the surplus cash?

We already established if you answered yes to question 1 you likely know how to proceed but speak with your tax and business advisor on how best to implement. If you answered yes to question 2, then determine the appropriate withdrawal strategy with your tax advisor. Here is a comprehensive list of options:

• Salary or bonus
• Taxable dividend
• Capital dividend
• Reducing paid-up capital
• Shareholder loan
• Repaying loan to shareholder
• Expense reimbursement

Next, if your answer was no to both questions, you can consider strategies to leverage the excess profit in your corporation to secure your family’s financial future.

Strategies for Distributing Funds to Invest Personally

When deciding how to allocate the profits in your corporation, we can start by considering whether we should distribute the funds to invest personally or invest the funds within the corporation. Here are a few strategies to distribute income to invest personally in your RRSP, TFSA, non-registered accounts and your spouse’s accounts if applicable.

• Maximize use of the small business deduction (lower tax rate on first $500,000 corporate net income) by paying a bonus to invest in an RRSP. This reduces corporate net income without affecting your current personal taxes if done correctly.
• Lump sum TFSA contributions using tax free distributions from your corporation such as a capital dividend or shareholder loan repayment.
• If your corporation is active, reduce current and future passive income in your corporation by distributing funds to invest in your personal accounts over time (i.e. topping up your TFSA over time). This helps the corporation reduce the impact of passive income on the small business deduction limit.
• Make use of the capital dividend account balance and refundable dividend tax on hand (RDTOH) balance to strip out funds to invest personally in an advantageous way.

Careful attention is required when funding your spouse’s accounts and joint accounts especially if they are not a shareholder of the corporation. Incorrect implementation can result in income taxed in your hands instead of your spouse’s hands.

Finally, many wonder whether they should invest personally or pay down personal debts faster. You may consider making principal payments on your debt as an alternative option to “invest” as it will grow your personal net worth. To help with your decision, you can compare the interest rate on the debt to the expected investment growth rates and consider how long you are willing to service the debt.

In reality, you may want to consider implementing more than one of these strategies at the same time. Investment, tax, and legal professionals can help you execute the right strategies for your situation.

Strategies for Investing Within Your Corporation

Many options exist to use the cash in your corporation to fund your retirement, estate, and charitable goals. The default option is typically deferring dividends by using a corporate investment account. Important tax and sometimes legal considerations apply when investing inside your corporation (see our article Maximizing After Tax Wealth from Your Corporation). Other than additional tax and legal consideration, investing in a corporate investment account is relatively straightforward. Next, we will examine other wealth management strategies you can use within your corporation. Most, if not all, the following strategies also provide creditor protection of your corporate retained earnings when executed correctly.

Purifying Your Corporation

If you are not retired, you may want to consider setting up a holding company to invest your excess corporate profits. This will help with purifying your business to make use of your lifetime capital gains exemption (LCGE) upon sale.

Individual Pension Plan (IPP)

Your corporation may set up an individual pension plan (IPP) for you and certain family members if they are also employees. An IPP is a defined benefit registered pension plan used to maximize tax-deferred retirement savings along with offering creditor protection. Like an RRSP, the income is taxable in retirement.

Retirement Compensation Arrangement (RCA)

A compliment to an IPP is a retirement compensation agreement (RCA). Your corporation may deposit funds to an RCA to provide a supplemental pension benefit and creditor protection. Contributions are deductible from corporate income where 50% may be invested within the plan and the other 50% is remitted as a refundable tax to CRA. All taxable income from investing will be subject to 50% refundable tax. In retirement, the income is taxable and $1 of refundable tax is recovered for every $2 paid out of the RCA making it possible to recover 100% of the refundable tax if the plan is depleted. This plan may also be utilized to retain high income employees.

Corporate Life Insurance

A different approach you can take to invest in your corporation is using corporate life insurance to provide retirement funds and lower taxes on your estate. The following points summarize the mechanism:

1. The corporation applies for a life insurance policy on your life.
2. The corporation makes additional contributions to the policy above and beyond the annual policy premiums (within certain limits).
3. The contributions grow the value of the policy on a tax-sheltered basis.
4. When you need income in retirement, your corporation can use the cash surrender value of the policy as collateral for loans. The funds borrowed by your corporation are then used to provide retirement income to you while income from the policy covers the loan.
5. Upon your death, the insurance proceeds are paid to your corporation tax-free, creating or increasing your corporation’s Capital Dividend Account (CDA) in the amount of the insurance proceeds in excess of the policy’s adjusted cost.
6. Your corporation may use the proceeds to repay the loan.
7. Finally, the net amount can be used to pay a dividend to your estate, the majority of which should be a tax-free dividend as a result of the CDA balance from the insurance proceeds.

Provided the insurance policy remains within certain limits, income from the policy would not be included in passive income and thus would not reduce the small business deduction. Additionally, the policy can be set up with an objective of stable dividends to grow the value (participating whole life insurance) or with an investment account offering various investment options (universal life insurance). The policy can be funded from surplus retained earnings, your existing corporate investment account, or an annuity depending on your situation and preference.

In summary, there a range of wealth management options available to you as a business owner or an incorporated professional to grow your overall wealth. However, not all of the above approaches will fit your needs, so it is important to discuss with your tax, legal, and investment professionals which ones are right for you.

If you are interested in discussing strategies you can use for your specific situation, please contact us today – we are happy to help.

This article may contain strategies, not all of which will apply to your particular financial circumstances. The information in this article is not intended to provide legal, tax, or insurance advice. To ensure that your own circumstances have been properly considered and that action is taken based on the latest information available, you should obtain professional advice from a qualified tax, legal, and/or insurance advisor before acting on any of the information in this article.